Gross Income Meaning
Gross income is the profit margin earned by a company from its operating activities and is denoted as sales as reduced by the cost of goods sold, which means the cost associated directly with the sale of goods sold by the company. It represents that income which an entity earns without incurring non-operating expenses such as interest, rent, electricity etc. It is reflected as a separate item in the income statement of the company as per GAAP.
It can be calculated by reducing the cost of goods soldCost Of Goods SoldThe cost of goods sold (COGS) is the cumulative total of direct costs incurred for the goods or services sold, including direct expenses like raw material, direct labour cost and other direct costs. However, it excludes all the indirect expenses incurred by the company. from the revenue of the entity.
The cost of goods sold refers to the direct cost that is incurred for the production of the goods. It includes the cost of material, labor, packaging, freight cost, and other direct costs.
All non-operating expensesNon-operating ExpensesNon operating expenses are those payments which have no relation with the principal business activities. These are the non-recurring items that appear in the company's income statement, along with the regular business expenses. are excluded from calculating it, and the only production linked expenses are taken into consideration.
Examples of Gross Income
Let us understand the calculation by way of the following examples.
A company engaged in the sale of motor parts earned a revenue of $10,000 during the year. The company incurs the following expenses during the year.
- Raw Material Cost: $3,000
- Labor Wages: $4,000
- Sales Commission: $500
Calculation of Cost of Goods Sold can be done as follows,
COGS formula = Raw Material + Labor Cost + Sales Commission
- = $3,000 + $4,000 + $500
- = $7,500
- = $10,000 – $7,500
- = $2,500
A company involved in a trade of goods managed to earn revenue of $ 12,000 during the year. Also, the following extracts of the company’s books of accounts are given.
- Opening stockOpening StockOpening Stock is the initial quantity of goods held by an organization during the start of any financial year or accounting period. It is equal to the previous accounting period's closing stock, valued in accordance with appropriate accounting standards based on the nature of the business.: $300
- Closing stockClosing StockClosing stock or inventory is the amount that a company still has on its hand at the end of a financial period. It may include products getting processed or are produced but not sold. Raw materials, work in progress, and final goods are all included on a broad level.: $250
- Purchases: $3,000
- Wages: $5,000
- Salaries: $4,000
- Interest: $1,000
- Freight: $500
Calculation of Cost of Goods Sold can be done as follows,
COGS = Raw material + Labor costLabor CostCost of labor is the remuneration paid in the form of wages and salaries to the employees. The allowances are sub-divided broadly into two categories- direct labor involved in the manufacturing process and indirect labor pertaining to all other processes. + Freight
COGS = (Opening Stock + Purchases – Closing Stock) + Labor Cost + Freight
- = ($300 + $3,000 – $250) + $5,000 + $500
- = $8,550
It is to be noted that salaries and interest expense will not form part of COGS are these are not directly related to the production of the goods.
- = $12,000 – $8,550
- = $3,450
Gross vs. Net Income
- Gross income means the amount of profit that is earned by the company from its business before incurring the indirect expenses. Net income represents the profit that is left after reducing the indirect expensesIndirect ExpensesIndirect expenses are the general costs incurred for running business operations and management in any enterprise. In simple terms, when you want to buy grocery from a supermarket, the transportation cost to get you to the supermarket and back is the indirect expenses. such as salary, rent, interest, rent, etc.. It can be calculated as follows:
- It represents the income earned from the main business. Net income reflects the overall income of the business after reducing all expenses. Net profit includes the effect of all expenses. It is not limited to just direct expenses, as is the case in gross income, which considers the cost of goods sold, i.e., the expenses related to the production of goods. An income statement shows revenue and cost of goods sold, followed by gross income, and after other expenses, net income is shown, which is a bottom-line item in the balance sheetThe Balance SheetA balance sheet is one of the financial statements of a company that presents the shareholders' equity, liabilities, and assets of the company at a specific point in time. It is based on the accounting equation that states that the sum of the total liabilities and the owner's capital equals the total assets of the company..
- Analyzing it gives an idea if a company needs to increase the product price or reduce the product-related cost to increase its gross income. On the other hand, if the net income of the company is very low as compared to gross, it may suggest that the company needs to cut its other expensesOther ExpensesOther expenses comprise all the non-operating costs incurred for the supporting business operations. Such payments like rent, insurance and taxes have no direct connection with the mainstream business activities.. It does not take into account other incomes, and it considers only the revenue from the sale of goods and services. In comparison, net income takes into account other incomes as well, such as interest income, dividend income, etc.
Gross Income is an indicator of the company’s profitability of its primary business. It is an essential factor that is considered by the stakeholders while evaluating the company as it reflects how effectively a company is managing its affair. It represents the profit earned from the main business of the company.
This article has been a guide to Gross Income and its Meaning. Here we discuss step by step calculation of gross income along with its formula, examples, and its differences from a net income. You can learn more about from the following articles –